The living trust is a tried-and-true means of providing for one’s heirs and avoiding probate of title to the home. A trust of this type should be distinguished from other kinds of land trusts—for example, an anonymity trust that has no probate objectives, or an investment trust that contemplates a transfer of underlying ownership by means of an assignment of beneficial interest (described in the next chapter on land trusts). There is another category—testamentary trusts—which take effect upon death of the trustor. These are not discussed in this article.
This article focuses on revocable living trusts, which comprise the great majority of homestead trusts formed in the U.S. Irrevocable living trusts are a tax-driven alternative (primarily for the very wealthy) as opposed to revocable trusts which have as their primary goal avoidance of probate. As such, irrevocable trusts are usually created and implemented by a specialized tax attorney in conjunction with a CPA. We will not address irrevocable trusts in this article.
A Living Trust as Part of an Estate Plan
A living trust that includes the homestead should be considered, along with a pour-over will, as part of most middle-class estate plans. Note that the emphasis here is on probate avoidance and not asset protection. Why? Because homesteads are already protected in Texas from forced sale to satisfy judgments. Tex. Const. Art. XVI, Sec. 50; Prop. Code Chs. 41, 42. So it is useful to generally distinguish between homestead-exempt assets (protected) and cash or investment assets (generally unprotected).
Should living trusts be used for the long-term holding of rental properties and other investments? We see this frequently promoted in investment and asset protection seminars. The problem is that trusts have no liability barrier as do LLCs, corporations, and limited partnerships, and a liability barrier should be a priority for real estate investors. An LLC is usually the preferred vehicle for real estate investing, not a trust.
Creating a Living Trust for the Homestead
Three steps are involved: (1) establishing the trust with a signed trust agreement; (2) executing and filing a warranty deed conveying the home into the trust; and (3) executing a pour-over will to move miscellaneous assets into the trust upon death.
As with other trusts, a trustor establishes the trust and conveys property into it. A trustee (or co-trustees if husband and wife) directs trust affairs on behalf of the beneficiaries (often the children). Since title remains in the trust, and the trust does not die, the surviving beneficiaries automatically “inherit” the trust property but without probate or other involvement by courts or lawyers.
The trust agreement should state the trust’s purpose in general terms along the following lines: “to hold, preserve, maintain, and distribute the Trust Property for the benefit of the Beneficiaries, including but not limited to payment of expenses for their respective health, education, maintenance, and support as the Trustee, acting in his or her sole discretion, deems reasonable, prudent, and necessary.” Texas law confers wide powers upon a trustee including selling and purchasing trust property but imposes a fiduciary duty in the management of the trust and its assets.
The trustor usually reserves the right to revoke or amend the living trust for the homestead. The terms of the trust are therefore not finally fixed until the trustor dies (or, in the case of husband and wife co-trustees, when the surviving spouse dies) at which time most living trusts become irrevocable. No deed or probate is required. Even though Texas has an expedited probate process, the result may be a considerable saving of time, effort, and attorney’s fees.
The trust agreement, unlike the warranty deed that follows it, should not be recorded. It is a private and confidential document, the terms of which need not even be disclosed to the beneficiaries.
A spendthrift clause is usually included that prohibits a beneficiary from assigning his or her interest in the trust to creditors.
The Homestead as Trust Property
Trust property in Texas may be of any type, whether personal or real, and that includes the homestead. Additional property may be transferred into trust at a later date after the trust is established.
Real property is conveyed into trust by general or special warranty deed recorded in the county clerk’s real property records. The deed should make certain specific recitals concerning the homestead nature of the property. Conveying the property by deed into the living trust is an essential part of the process since the trust agreement, by itself, does not transfer title.
The trust need not formally assume existing liabilities on trust property in order for the transfer to be effective. Property can be taken “subject to” existing indebtedness (i.e., without the trust or trustee taking any liability for the debt) or the debt can be assumed or wrapped. “Subject to” is more common in the trust context.
Transferring property into a revocable living trust does not reduce a trustor’s assets for Medicaid purposes. Trust property is still counted by Medicaid as belonging to the trustor.
Preserving the Homestead Tax Exemption with a Qualifying Trust
Living trusts for the homestead should be carefully drafted so as to be a “qualifying trust” under applicable statutes (details below). They should contain language that (1) claims homestead protections against execution on a judgment pursuant to Texas Constitution Article XVI, Section 50 and Property Code Chapters 41 and 42; and (2) preserves any available homestead tax exemption whether currently on file or not. It is prudent to make express recitals to this effect in the trust agreement even though Property Code Section 41.0021 states that transfer of a homestead into a qualifying trust retains the homestead character of the property. Similar language should also be recited in the deed into the trust so as to make it clear to the local taxing authorities that a qualifying living trust has been established for the homestead.
Note that we are talking about two different aspects of “homestead” here—the exemption from judgment execution generally and also the specific tax exemption granted by the local appraisal district. These are related, but conceptually distinct, and are often conflated.
The primary law applicable to qualifying trusts is found in Property Code Section 41.0021:
Section 41.0021. Homestead in Qualifying Trust
(a) In this section “qualifying trust” means an express trust:
(1) in which the instrument or court order creating the express trust, an instrument transferring property to the trust, or any other agreement that is binding on the trustee provides that a settlor or beneficiary of the trust has the right to:
(A) revoke the trust without the consent of another person other than a spouse who is also a settlor of the trust;
(B) exercise an inter vivos general power of appointment over the property that qualifies for the homestead exemption, either alone or when aggregated with property subject to an intervivos general power of appointment held by a spouse who is also a settlor of the trust; or
(C) use and occupy the residential property as the settlor’s or beneficiary’s principal residence at no cost , or rent free and without charge, except for taxes and other costs and expenses specified in the instrument or court order: (i) for the life of the settlor or beneficiary; (ii) for the shorter of the life of the settlor or beneficiary or a term of years specified in the instrument or court order; or (iii) until the date the trust is revoked or terminated by an instrument or court order that describes the property with sufficient certainty to identify the property and that is recorded in the real property records of the county in which the property is located; and
(2) the trustee of which acquires the property in an instrument of title or under a court order that: (A) describes the property with sufficient certainty to identify the property and the interest acquired; and (B) is recorded in the real property records of the county in which the property is located.
(b) Property that a settlor or beneficiary occupies and uses in a manner described by this subchapter and in which the settlor or beneficiary owns a beneficial interest through a qualifying trust is considered the homestead of the settlor or beneficiary under Section 50, Article XVI, Texas Constitution, and Section 41.001.
(c) A married person who transfers property to the trustee of a qualifying trust must comply with the requirements relating to the joinder of the person’s spouse as provided by Chapter 5, Family Code.
(d) A trustee may sell, convey, or encumber property transferred as described by Subsection (c) without the joinder of either spouse unless expressly prohibited by the instrument or court order creating the trust.
(e) This section does not affect the rights of a surviving spouse or surviving children under Section 52, Article XVI, Texas Constitution, or Chapter 353, Estates Code.
The statute makes clear that in order to constitute a qualifying trust, the person residing there must be either a trustor or a beneficiary. A trustee who is not also a trustor or a beneficiary cannot claim a qualifying trust.
There is also a parallel provision in Tax Code Section 11.13(j):
11.13. Residence Homestead
(j) For purposes of this section:
(1) “Residence homestead” means a structure (including a mobile home) or a separately secured and occupied portion of a structure (together with the land, not to exceed 20 acres, and improvements used in the residential occupancy of the structure, if the structure and the land and improvements have identical ownership) that: (A) is owned by one or more individuals, either directly or through a beneficial interest in a qualifying trust; (B) is designed or adapted for human residence; (C) is used as a residence; and (D) is occupied as the individual’s principal residence by an owner, by an owner’s surviving spouse who has a life estate in the property, or, for property owned through a beneficial interest in a qualifying trust, by a trustor or beneficiary of the trust who qualifies for the exemption.
(2) “Trustor” means a person who transfers an interest in real or personal property to a qualifying trust, whether during the person’s lifetime or at death, or the person’s spouse.
(3) “Qualifying trust” means a trust: (A) in which the agreement, will, or court order creating the trust, an instrument transferring property to the trust, or any other agreement that is binding on the trustee provides that the trustor of the trust or a beneficiary of the trust has the right to use and occupy as the trustor’s or beneficiary’s principal residence residential property rent free and without charge except for taxes and other costs and expenses specified in the instrument or court order: (i) for life; (ii) for the lesser of life or a term of years; or (iii) until the date the trust is revoked or terminated by an instrument or court order that describes the property with sufficient certainty to identify it and is recorded in the real property records of the county in which the property is located; and (B) that acquires the property in an instrument of title or under a court order that: (i) describes the property with sufficient certainty to identify it and the interest acquired; and (ii) is recorded in the real property records of the county in which the property is located.
Must a qualifying trust be revocable?
A common misconception is that a “qualifying trust” must be a revocable living (or inter vivos) trust; however, the statute inserts an “or” to provide, by implication, that an irrevocable trust qualifies so long as the trustor or the beneficiary of the trust retains the use and occupancy of the home as the trustor’s or the beneficiary’s principal residence at no cost to the trustor or beneficiary. Accordingly, it is common for appraisal districts to require that the trust agreement (or the deed conveying the property into trust) contain a provision that the trustor may continue living in the property without paying rent or costs.
FNMA Requirements for Trusts Eligible to be a Borrower
If a living trust is going to borrow or refinance utilizing a FNMA loan, there are requirements similar to those for a qualifying trust under Texas law. Specifically, if the trust is to be the borrower, then the “inter vivos revocable trust must be established by one or more natural persons, solely or jointly. The primary beneficiary of the trust must be the individual(s) establishing the trust. If the trust is established jointly, there may be more than one primary beneficiary as long as the income or assets of at least one of the individuals establishing the trust will be used to qualify for the mortgage. The trustee(s) must include either the individual establishing the trust (or at least one of the individuals, if there are two or more) or an institutional trustee that customarily performs trust functions and is authorized to act as trustee under the laws of the applicable state. The trustee(s) must have the power to mortgage the security property for the purpose of securing a loan to the individual (or individuals) who are the borrower(s) under the mortgage or deed of trust note.” (See FNMA Selling Guide B2-2-05 which can be found online).
Hybrid Trusts: Homestead Plus Investments
What about other assets other than the homestead, either personal or business? Can the homestead trust contain these as well? The answer is a tentative yes, but individual circumstances need to be examined carefully to make sure this is a suitable approach. One asset that can be included is the trustor’s interest in a holding company (that portion of our recommended two-company structure that is dedicated to owning hard assets). An LLC membership interest is personal property, and like any other personal property can be bequeathed by means of a last will and testament; but placing it in a living trust avoids any necessity for probate. The downside, at least from a general asset protection perspective, is that one is mixing the homestead with a business asset that could have potential liability associated with it. Again, care is needed on a case-by-case basis in order to determine if a hybrid approach is workable and acceptable in any given case.
Note that it would never be a good idea to include an investor’s dedicated management company under the same trust umbrella as the homestead, since the management LLC’s express purpose is to deal with the public and third parties—and thus be an intentional target for liability and litigation. Mixing this with the homestead in the same vehicle would be inadvisable.
As a general principle, one should not ask any particular entity to do more work than it prudently can or should be doing. In the case of trust planning, if there are multiple assets and interests that need to be considered and planned for, then one can always create a second trust, separate from the trust that holds the homestead—and that would be the safer course.
Blending Anonymity Techniques with Living Trusts for the Homestead
There is a potential problem in seeking anonymity when deeding the homestead into a living trust. By “anonymity” we refer to the practice of deeding the trust property into the name of a generic trust – e.g., the 123 Oak Street Trust – with no mention of the name of the trustee. Since trusts are not legal entities, this is technically not the correct way to do it; however, anonymity is nonetheless accomplished, at least until a title company later challenges this practice in the lead-up to a subsequent sale of the homestead. This title company challenge can be anticipated and met by preparing two deeds: one deed is filed at the time the trust is created (not showing the name of the trustee) and another deed, which does show the name of the trustee, is held in reserve for the inevitable challenge that will occur later. The idea is that the second deed can then be recorded, curing the problem ex post, while still having maintained anonymity for the duration of ownership. A creative but workable approach.
It goes without saying that this must be done very carefully in the case of a homestead, since titling and trust issues are likely to become an issue only after the trustor or trustee is deceased and therefore unavailable to sign any curative deed that a title company may demand. So that second deed (sometime called a “deed in the drawer”) must be pre-executed, notarized, and available when it is needed. Do not even think about trying this anonymity technique without a lawyer who understands the process. Achieving anonymity, even partial anonymity, is a challenge. The American legal system is built for disclosure, not concealment, so creative efforts and often significant expense are involved.
Unlike investment land trusts, federal law creates a living trust exception to the enforcement of due-on-sale clauses on homesteads that remain owner-occupied. Garn-St. Germain Depository Institutions Act, 12 U.S.C. Sec. 1701j-3. Due-on-sale is therefore not a factor when contemplating a living trust for the homestead, so long as the trustor intends to continue living there.
Addition of a Pour-Over Will
It is good practice for the trustor to execute a last will and testament that contains pour-over provisions designed to include in the trust estate any property or assets that were not previously designated. Such assets “pour over” into the trust. In this way, the trust and the will work together as part of an overall strategy. It is also possible to have life insurance paid directly to the living trust. This may be advantageous for purposes of promptly paying off liens on the homestead.
Drafting and Maintaining the Trust
The purpose of a living trust is serious business and should never be relegated to fill-in-the-blank or Internet forms, most of which are not specifically designed to comply with Texas law. Additionally, it may be necessary to make amendments to the trust agreement over the years, especially if one homestead is exchanged for another or if the names of beneficiaries change. Amendments are usually easy to do. Trust maintenance can be as important as trust formation.
From Our Case Files: Why You Need a Plan
I reside in my mother’s home which was left to me when she passed away a year ago, dying without a will. I was my mother’s sole caregiver and moved in with her to take care of her until she died. She kept cash in the house and since my car was old I just bought a new truck with it.
Our family situation is complicated. My sister, who ran away at age 14 and never returned, has filed suit saying that she is entitled to the house. Now I’m afraid the court will put me out and give our mother’s home to my sister, who wasn’t there for my mother. All my sister wants is the money, everyone knows that, even though she is very well-off because she married three men for their money and then divorced all of them.
My sister claims she’s been paying the taxes on the home. She is lying. I am the one who has paid all of the taxes on this home and also the maintenance, but I don’t have any records. My older brother just returned after being gone for years. He parked his 40-foot RV in the driveway and hooked up to the electricity without asking me and now there’s no room for my new truck. We’re not on speaking terms, since his Doberman bit my girlfriend on the leg (she won the prize for best legs in high school). I want him evicted.
My mother and I talked about her making a will or a living trust years ago but didn’t do it because attorneys were too expensive. We decided to make a will from the Internet, but I showed it to a neighbor last week and he says it isn’t any good in Texas. I don’t want to lose my home. I have savings but I don’t want to spend any of it on a lawyer. I’m a disabled vet, and I also have Lupus from when from working at the refinery in Baytown (it’s in the water there). Will you help me pro bono?
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well since we are not tax practicioners and do not offer tax advice. This firm does not represent you (i.e., no attorney-client relationship is established) unless and until it is retained and expressly agrees in writing to do so.
Copyright © 2023 by David J. Willis. All rights reserved worldwide. Reproduction or re-use of any this material for any purpose without prior written permission and full attribution is strictly prohibited. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, https://www.LoneStarLandLaw.com.